02/18/2014

Be Prepared: Fully Document All Potentially Allowable Costs

The U.S. Court of Appeals for the Federal Circuit, in Kellogg Brown & Root Services, Inc. v. United States, No. 13-5030 (Fed. Cir. Feb. 3, 2014), recently affirmed a lower court decision denying Kellogg Brown & Root Services, Inc. (“KBR”) more than $6 million in costs it incurred while providing food services to the United States Army in Iraq. The reason for the decision: KBR did not sufficiently demonstrate that the allegedly allowable costs it incurred were “reasonable” pursuant to FAR 31.201-3.

KBR and the Army entered into a contract for KBR to provide logistical support for Army operations in Iraq. The Army issued two task orders for the installation, operation and maintenance of a dining facility near Mosul, Iraq. KBR subcontracted the work on the task orders to ABC International Group (“ABC”). ABC originally proposed to construct a prefabricated metal dining facility with the expectation that it would handle approximately a 2,600 headcount at the facility. Shortly after KBR awarded the subcontract, the Army ordered KBR to stop construction of the metal dining facility and begin construction of a dining facility made of reinforced concrete. The Army also increased the estimated headcount from 2,573 to 6,200+ persons. Instead of rebidding the contract, KBR simply asked ABC to prepare a proposal for the new requirements.

Under ABC’s revised proposal, the anticipated monthly cost for the new facility and new headcount would be approximately $2,706,600 – nearly triple the original subcontract monthly amount. KBR reviewed and approved ABC’s cost proposal. However, there were admitted material flaws in KBR’s internal Price Negotiation Memorandum justifying the increased prices. Additionally, neither ABC nor KBR provided any specific detail as to how the new building requirements and new headcounts could realistically lead to triple the original proposed costs.

KBR and ABC completed work on the task order in June 2005 and subsequently submitted their costs for payment. In 2007, the Defense Contract Auditing Agency (“DCAA”) suspended payment of certain costs paid by KBR to ABC. KBR submitted a price justification based on building similar structures in Jordan and Iraq. Nonetheless, DCAA still disapproved reimbursement of $12,529,504 that KBR had paid to ABC for equipment, the dining facility, labor and consumables.

KBR filed suit in the U.S. Court of Federal Claims (“COFC”). The COFC held that KBR failed to demonstrate “that it employed sound business practices and acted as a reasonably prudent business person in accepting ABC’s proposed prices.” The COFC, however, determined that KBR was entitled to recover $6,779,762, the stipulated costs for construction of the concrete dining facility. KBR appealed.

The Federal Circuit affirmed the COFC. It held that “[c]ost reasonableness is a question of fact” and found no “clear error” in the COFC’s factual findings. In particular, the Federal Circuit cited to the erroneous Price Negotiation Memorandum and lack of any contemporaneous documentary support for ABC’s price proposal when it held that “the fact that Change Order 1 tripled the price for roughly double the troops should have prompted KBR to balk, or at least request an explanation of how ABC arrived at its proposal. Under these facts, we see no clear error in the determination by the Court of Federal Claims that KBR failed to show ‘that it employed sound business practices and acted as a reasonably prudent person in accepting ABC’s proposed prices.’”

KBR argued that its own negligence in its Price Negotiation Memorandum as well as the fact that the Army made an urgent request for support services in a war zone environment should be factors in support of the reasonableness of ABC’s prices. The Federal Circuit rejected these, and other, arguments.

The clear message from this decision is that, to the extent there are any cost reasonableness issues involving anticipated allowable costs, contractors should carefully and completely document and support the allowability and reasonability of each such cost. Proper documentation and support should help shift any DCAA or other audit discussion from a threshold allowability question to a discussion of the quantum of the allowable costs.